One Last Post on Student Loans, Then...

December, 2017

Washington -- There have been many questions asked of me about how I knew PHEAA's claims were false in the recent case U.S. ex rel. Oberg v. PHEAA. Rather than answer each person individually, I'll post a response to all and hope it suffices before moving on to other topics.

In the spring of 2003, while employed at the U.S. Department of Education's Institute of Education Sciences, I noticed PHEAA's claims for government funds were growing in one particular category: subsidies for student loans funded by tax-exempt bonds created prior to 1993. The total principal balances of these loans were growing when they should have been declining as loans were paid off and the bonds retired or defeased. Ten years earlier, Congress had cut off its special subsidies for such loans (guaranteeing loan holders a 9.5% annual return), grandfathering in only loans from bond estates created before 1993. These balances should not have been growing as they were; the grandfathers were not supposed to have progeny.

I checked the 1993 statue; nothing there explained it. I checked the applicable regulations and found nothing there, either. Loans eligible for the 9.5% return could be created only from a short list of qualifing funding sources, none of which applied to what I was observing. I asked around the Department of Education if anyone could explain PHEAA's growing balances and claims. No one could.

In over four decades of budget and fiscal administration, I had seen my share of money-laundering scams and schemes, so I became suspicious that PHEAA's claims were illegal. It would not be that hard simply to move loans around among new and old bond estates, essentially "washing" loans made with post-1993 money by putting them however temporarily into pre-1993 estates. Or transferring old loans into new estates where they would retain their 9.5 return characteristics, taking the proceeds from that transaction and putting it back into the old estate, then issuing a new loan and claiming it came from an old estate and was also eligible for the 9.5% return.

That, it turns out, is what PHEAA was doing as it grew its portfolio of 9.5% guaranteed loans from under $900 million to over $2.1 billion.

This was hugely lucrative for PHEAA. In the low-interest rate environment of 2002-2005, student borrowers paid rates sufficiently high on the loans that the government paid little or no subsidy on loans that were not guaranteed a 9.5% return.

PHEAA was not the only student-loan entity making false claims through loan and bond manipulations. Others started to emulate PHEAA. One lender's new bond issue was analyzed by a Wall Street rating agency, which made reference to the lender's 9.5% loans. I took off a day from work and called the agency from my home to get more information. The person who answered the phone said it was a coincidence that I called, as she had just been talking to their legal department about where all these loans were coming from. Their conclusion was that lenders would have to escrow funds made from false claims from illegally created loans, in preparation for soon paying the claims back to the government. That solidified my view that I knew what PHEAA was doing.

Of course I had emailed PHEAA earlier for an explanation of what they were doing. They dissembled twice and didn't answer the third time.

When a PHEAA official took the stand in the recent trial, he could not identify which of the five qualifying sources of funds PHEAA used to create new 9.5% loans. He looked at the applicable regulation and wrongly offered "all of the above." He finally took a stab at the fourth qualifying source (proceeds of pre-1993 loan sales) but that was a wrong answer because PHEAA itself did not consider the transfers to be sales and had said so in sworn depositions. The correct answer was "none of the above" but PHEAA instead fell back on half an answer, that a Department letter from 1996 provided that transfers of loans from old money estates to new money estates carried the 9.5% guarantee with them. But the letter said absolutely nothing about using the proceeds from the transaction to create yet another 9.5% loan. Any loans created with such proceeds would necessarily be subject to the usual subsidy provisions and have no 9.5% guarantee.

Department of Education officials who paid the false claims were asleep, or thought better of rocking the boat, because former PHEAA people in the Department were their bosses. (Or other bosses illegally holding stock in banks.) They may have been aware of what happened to me when I raised the matter in late 2003: I was told not to look into it, in a decidedly threatening reply. More than once colleagues told me, "Got to put food on the table," meaning job security was more important than stopping a money-laundering scheme, even as the scheme grew enormously, into the billions of dollars. Only when the Inspector General got around to looking at the whole mess were PHEAA claims finally exposed as false.

Part of the problem at the Department of Education is that few people there have sufficient experience in public finance. I could count them on the fingers of one hand. When I retired in 2005, the director of the National Center for Education Research pleaded with me to stay on because no one there knew anything about postsecodary finance. So hire someone else, I said, but that never happened.

That's the story of how I knew PHEAA's claims were false. In retrospect, I would say it was right out of Money Laundering 101.

Now, on to other topics, such as how the 2018 Farm Bill, unless greatly revised, will hurt rural America as it contributes to the national epidemic of obesity, diabetes, and drug abuse. That may be an even bigger issue than a lost generation of student-loan borrowers, which I bequeath to anyone who wants to take it up, at least for now.